Advanced Underwriting Consultants

Ask the Experts – June 12, 2014

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: My client is trying to decide between setting up a SIMPLE or SEP IRA for her small business. What should I tell her?

Answer: Without more details, you can only speak in generalities. You should start with the differences between the two.

A SIMPLE IRA (savings incentive match plan for employees) is very similar to a 401(k) plan in that it’s primarily a way for an employee to choose to contribute the employee’s money to a pension plan.

SIMPLE IRAs may include both employee deferrals and employer contributions. The employer must either (1) match the employee’s deferral dollar-for-dollar, generally up to 3% of the employee’s salary; or (2) make a 2% nonelective contribution to all eligible employees—regardless of whether the employee made a contribution.

An employee’s deferral limit for a SIMPLE IRA is $12,000 (in 2014, indexed for inflation).  The employee’s deferral must be deposited by the employer within 30 days from the end of the month in which the election was made, and the employer’s matching or 2% nonelective contribution must be made by the time tax returns are due in the following year.

To implement a SIMPLE IRA, an employer must have 100 or fewer employees who receive more than $5,000 per year. Every employee who earns at least $5,000 from the employer is an eligible employee and must be allowed to participate in the SIMPLE plan.

A SEP IRA (simplified employee pension) is easier to describe and implement than a SIMPLE IRA. It’s essentially an IRA set up on behalf of an employee to which the employer makes contributions based on a percentage of the employee’s compensation (the maximum compensation taken into account is $260,000 in 2014). The percentage contributed must be the same for every eligible employee.  There are no employee deferrals into a SEP plan.

An eligible employee is one who (1) is 21 years or older, (2) has worked 3 of the last 5 years or more, and (3) earned $550 in compensation. The contribution limit is 25% of the employee’s salary, or $52,000 (in 2014, indexed for inflation), whichever is lesser.

Understanding the differences between these plans can help your client decide which plan makes more sense. For example, if the business consists of only your client, the most important aspect is probably the contribution limits.

If the business generates relatively small amounts of income, a SEP IRA will limit the owner’s contribution. For example, let’s say your client has a side business bringing in $16,000 per year in salary. Under a SEP, the most he may contribute is $4,000 (25% of $16,000). On the other hand, with a SIMPLE IRA, he may make the full $12,000 contribution and have the business make a matching $480 contribution (3% of $16,000).

But if he earns $100,000 per year through his business, the business may contribute $25,000 (25% of $100,000) under a SEP, and he can only defer $12,000 (plus a $3,000 matching contribution from the business) under a SIMPLE plan.

Sources: I.R.C. § 408(k), (p); § 402(h)(2)(A).

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Ask the Experts – May 28

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: I have a client who received $100,000 as the beneficiary of his deceased wife’s life insurance policy. My client and his wife were in bankruptcy at the time of her death. Will the death benefit be protected from both of their creditors?

Answer: It depends on the state law and other facts surrounding their situation.

For example, consider the recent Alabama bankruptcy case, In re White, in which a married couple was in Chapter 13 bankruptcy when the wife died. Prior to filing a petition for bankruptcy relief, the debtors purchased a $50,000 life insurance policy on the life of the wife through the husband’s employer. The wife was the insured and policy owner, while her husband was designated as the sole beneficiary.

The wife died and the husband received $50,000. Ordinarily, money received during a bankruptcy plan would go to the bankruptcy estate and the trustee would dictate where that money was allocated. However, the husband asserted that the funds were exempt from the bankruptcy estate because of the following state asset protection statute:

(b) If a policy of insurance . . . is effected by any person on the life of another in favor of the person effecting the same . . . the latter shall be entitled to the proceeds and avails of the policy as against the creditors, personal representatives, trustees in bankruptcy and receivers in state and federal courts of the person insured. If the person effecting such insurance . . . is the wife of the insured, she shall also be entitled to the proceeds and avails of the policy as against her own creditors, personal representatives, trustees in bankruptcy, and receivers in state and federal courts.

Alabama Code Section 27-14-29(b). The statute is rife with legalese, but here’s a translation: if the husband effects a life insurance contract on his wife’s life and names himself as the beneficiary, then the death benefit is exempt from both of their bankruptcy estates.

The husband argued that he “effected” the policy because it was purchased through his employment and paid for with payroll deductions. The bankruptcy trustee disagreed, claiming that the $50,000 death benefit should go to the bankruptcy estate—not to whomever the debtor-husband wants.

The bankruptcy court agreed with the trustee, reasoning that although the wife purchased the policy through her husband’s employment, and, although it was funded with payroll deductions, the policy was owned by the wife, and it was therefore not effected by the husband. Therefore, this particular Alabama creditor exemption did not apply to the husband, and the $50,000 death benefit was not protected from his creditors. (Note that it was protected from his wife’s creditors, but since they were jointly in bankruptcy, that made no difference.)

The White case reinforces the idea that a policy’s death benefit, when paid to a beneficiary going through a bankruptcy, might also be lost to creditors. The court’s decision hinged on its interpretation of the Alabama state law bankruptcy exemption and the ownership of the life policy on the deceased wife’s life. It probably never occurred to the husband in this case that policy ownership might make a difference as to whether he might be able to keep the death benefit later on. Even though state bankruptcy exemptions provided some protection for life insurance proceeds, the specific circumstances of this case didn’t extend those protections to the surviving husband.

Finally, the decision serves as a reminder (again) to life insurance professionals to

  • Review the ownership and beneficiary designations of all their clients’ life insurance and financial products on a regular basis.
  • Consider naming a spendthrift trust as beneficiary instead of the individual directly to protect beneficiaries who might have future financial difficulties.

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Ask the Expert – March 25

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question: My client runs a mid-sized business and asked me whether he is required under the Affordable Care Act to provide health insurance to his employees. What should I tell him? What are the penalties if he doesn’t comply?

Answer: The employer mandate doesn’t take effect until 2015, so he isn’t required to provide health insurance to his employees this year. We don’t have enough information to know whether he is required to provide health insurance next year or beyond, but we can provide you with the general rules regarding to whom the employer mandate applies, and the consequences of noncompliance.

Applicable Employers

In 2015, the employer mandate applies to employers with 100 or more full-time employees. These large employers are required to offer health insurance to their full-time employees and their dependents. A full-time employee is one who averages 30 hours per week of services. Employers are not required to provide health insurance to their employees’ spouses or part-time employees. However, part-time employees are partially counted toward whether the employer mandate applies. Starting in 2016, the employer mandate applies to employers with 50 or more full-time workers (and full-time equivalents).

Penalties

There are two types of penalties under the employer mandate. Each is computed monthly, but based on an annual penalty.

Starting in 2015, if an applicable employer offers health insurance to fewer than 70 percent (and generally 95 percent after 2015) of its employees and their dependents, and at least one employee receives a premium tax credit to help pay for insurance on an Exchange, then the employer faces a $2,000 penalty per year for each of its full-time employees. The first 80 employees are disregarded for the Type A Penalty purposes (30 starting in 2016). The $2,000 penalty is indexed for inflation beginning after 2014. Here’s an example to demonstrate how costly the Type A Penalty can become.

Suppose an employer has 1,000 full-time workers in 2014, but only offers insurance to 699 of its employees. Of the 301 employees not offered health insurance, only one receives a health care premium tax credit to purchase coverage on an Exchange. Nevertheless, the Type A Penalty applies, and the employer faces a $1.84 million penalty (1,000 full-time employees, less the 80 disregarded employees, times the $2,000 penalty for each full-time employee).

If the Type A Penalty does not apply because the employer offered coverage to more than 70 percent of its workers (95 percent starting in 2016), a $3,000 penalty per year may still apply based on the number of workers who received a premium tax credit to purchase insurance on an Exchange.

Assume that the employer offered coverage to 700 of its 1,000 full-time employees in 2015. Of the 300 not offered coverage, 100 obtained a health insurance premium tax credit on an Exchange. The Type B Penalty would apply to the employer, and it would incur a $300,000 penalty (i.e. $3,000 penalty × 100 workers).

Most employers don’t need to worry about the employer mandate because it won’t apply to them. However, the employer mandate rules can be highly technical and costly if not followed correctly. If your client is unsure whether his company is covered by the employer mandate, it’s a good idea for him to contact his business attorney.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.  

Ask the Experts – February 20

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax questions posed by producers.  Here’s the question of the day.

Question: I have a client whose life insurance policy terminated because his debt on the policy exceeded its cash value. Is the entire loan balance—including accumulated interest on the principal—treated as a distribution?

Answer: Yes. Consider the recently released Tax Court opinion, Black v. Commissioner, T.C. Memo. 2014-27 (2/14/14).

In Black, the taxpayer borrowed about $100,000 from his life insurance policy, which incurred an additional $90,000 in interest. The taxpayer failed to repay the loan, and the policy was terminated, satisfying and extinguishing the full debt.

The taxpayer had invested about $80,000 in the policy and contended that he was only required to include $20,000 in gross income from the deemed distribution (i.e. the loan principal, $100,000, less his investment in the contract, $80,000).

The Tax Court disagreed, holding that the entire debt—including the capitalized interest—should be treated as a distribution when the policy terminated. Therefore, the taxpayer should recognize $110,000 of gross income (i.e. the loan principal plus the capitalized interest, $190,000 total, less his investment in the contract, $80,000).

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.

Ask the Experts – August 22

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

 Question:  My client is leaving the employ of her 401K plan sponsor.  The client has a $40,000 outstanding loan against the 401K.  If she lets the loan lapse, and then contributes $40,000 to an IRA within 60 days, would that be a proper rollover?

Answer:  Yes, it seems so.

A plan loan is deemed a taxable distribution when the loan repayment is in default.  Default is determined based on the plan language.

The regulations say that a deemed distribution due to a loan default is an eligible rollover distribution.  Thus, the participant can replace the loan amount with outside funds inside a rollover IRA within 60 days of the date of default.  Here’s the excerpt from Treasury Regulation 1.402(c):

Q-9: What is a distribution of a plan loan offset amount, and is it an eligible rollover distribution?

 A-9: (a) General rule. A distribution of a plan loan offset amount, as defined in paragraph (b) of this Q&A, is an eligible rollover distribution if it satisfies Q&A-3 of this section. Thus, an amount equal to the plan loan offset amount can be rolled over by the employee (or spousal distributee) to an eligible retirement plan within the 60-day period under section 402(c)(3), unless the plan loan offset amount fails to be an eligible rollover distribution for another reason. See § 1.401(a)(31)-1, Q&A-16 for guidance concerning the offering of a direct rollover of a plan loan offset amount. See § 31.3405(c)-1, Q&A-11 of this chapter for guidance concerning special withholding rules with respect to plan loan offset amounts.

And here’s a link to a 2012 private letter ruling where the idea is discussed in more detail.

http://www.irs.gov/pub/irs-wd/1224046.pdf

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Question of the Day – May 2

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Here’s the question of the day.

Question:  My client made a gift of highly appreciated real estate to family members last year.  The client passed away this year.  Do the new owners receive a step-up in basis due to the original owner’s death?

Answer:   No.

Capital assets included in a decedent’s taxable estate at death get a step-up in basis to full fair market value.  Thus, someone inheriting capital property will be able to sell that property shortly after the decedent’s death with little or no capital gains tax.

Certain kinds of transfers prior to death may still cause the asset to be included in the decedent’s estate if the transfer was made within three years of a decedent’s death.  These kinds of transfers include gifts with a retained interest or gifts of life insurance.

An outright gift of property, even if done one day prior to the decedent’s death, gets carryover basis treatment, and there’s no step-up in basis for the recipient.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day. 

Question of the Day – January 30

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question:  My business owner client wants to offer life insurance in the company’s pension plan for participants.  Must the life insurance plan offer non-sex-distinct (i.e. – unisex) rates?

Answer:  Many life insurance companies in this market believe that the answer is yes.

In 1983, the United  States Supreme Court ruled that employers who offer  retirement annuity plans that pay smaller monthly benefits to women than  to  similarly  situated men violate the ban against sex discrimination in employment in Title VII  of the Civil Rights Act of 1964.  This case is often referred to as the Norris decision.

Companies involved in the administration of pension plans, including insurance companies, interpreted the result as requiring the use of non-sex-distinct annuities in conjunction with pension plans.  Many of the same companies decided that if unisex were required with regard to annuities, the decision would probably also require unisex with regard to life insurance.

Even though the Norris decision is nearly 30 years old, there have been no substantial subsequent court cases or regulations to clarify its scope with regard to pension-owned life insurance.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day. 

Question of the Day – August 1

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question: I am working with the widow of a member of the military.  Can she roll over the death benefit she received from his government insurance to a Roth IRA?

Answer: Maybe.

Here are the rules taken from IRS Publication 590:

Military Death Gratuities and Servicemembers’ Group Life Insurance (SGLI) Payments

If you received a military death gratuity or SGLI payment with respect to a death from injury that occurred after October 6, 2001, you can contribute (roll over) all or part of the amount received to your Roth IRA. The contribution is treated as a qualified rollover contribution.

The amount you can roll over to your Roth IRA cannot exceed the total amount that you received reduced by any part of that amount that was contributed to a Coverdell ESA or another Roth IRA. Any military death gratuity or SGLI payment contributed to a Roth IRA is disregarded for purposes of the 1-year waiting period between rollovers.

The rollover must be completed before the end of the 1-year period beginning on the date you received the payment.

The amount contributed to your Roth IRA is treated as part of your cost basis (investment in the contract) in the Roth IRA that is not taxable when distributed.

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Question of the Day – July 9

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question: My client is 53, and wants to avoid the 10% penalty tax on her IRA distributions.  Will the IRA custodian help her with calculated 72(t) distributions?

Answer: Some of them will, but it is not a requirement.

The Internal Revenue Code provides that taxable distributions from an IRA to a taxpayer younger than 59 ½ are subject to an extra 10% penalty tax unless there is a special exception.  One such exception is that the 10% penalty tax does not apply to distributions which are part of a series of substantially equal periodic payments made at least annually for the life or life expectancy of the individual or the joint lives or joint life expectancy of the individual and his designated beneficiary.  This is sometimes referred to as the 72(t) exception.

Once a taxpayer begins to take 72(t) distributions, the taxpayer must continue them for the longer of five years or until the taxpayer reaches age 59 ½.  If the taxpayer modifies the 72(t) distribution stream—perhaps by taking greater or lesser distributions from the IRA than those required under the 72(t) distribution strategy—all prior distributions intended to meet the 72(t) requirements will be subject to the penalty tax.

Some IRA custodians actively help their customers calculate and take 72(t) distributions.  Others do not support 72(t) at all.

If working with a client who intends to take 72(t) payments, we recommend that the advisor check with the IRA administrator to determine their willingness to actively participate in the 72(t) process.  For those administrators that will not help calculate 72(t) payments, the advisor should find out how the administrator will report distributions to the IRS on Form 1099-R for income tax purposes.

From the client’s perspective, it would be most helpful for 72(t) distributions to be coded as taxable distributions which are not subject to the penalty tax.  On Form 1099, that means that box 7 will have distribution code 2.

While Form 1099-R does not bind the IRS to accept that the distributions conform to 72(t), the proper 1099 coding makes it administratively easier on the taxpayer who is taking 72(t) payments.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.

Question of the Day – July 6

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax questions posed by producers.  Here’s the question of the day.

Question: My client is the insured under a life insurance policy owned by her mother.  Her mother recently passed away.  Does the policy now belong to my client?

Answer: Not necessarily.

When a third party owns a life policy, the insured has no ownership rights in the contract.  At the death of the owner, the policy transfers to the contingent owner, if one is named.

If there is no named contingent owner, the policy becomes an asset of the deceased owner’s estate.  The successor owner will be the person identified in the decedent’s will (if there is one) or by the intestate laws of the state of the decedent’s residence at the time of death.

The process for changing ownership when the policy is an estate asset is the probate process.  Probate is a highly structured court proceeding under which a judge supervises the transfer process.

Because of the costs and inconvenience associated with probate, we highly recommend that third party owners of life policies consider naming contingent owners for the policy.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.